Spotify - music's holy grail or a tune destined to fail

The word on everyone’s lips in the music industry (this week) is Spotify – and it’s ‘all you can eat’ business model for providing unlimited music streams to music fans either for free – if fans are prepared to put up with advertising – or for £9.99 per month as a premium service. As Spotify, launched by Swedish internet entrepreneur Daniel Ek, reached its first birthday, attention turned to figures released by Ek about the success of the service and his self-declared problems in getting what he considers workable deals with the record labels who control the rights to sound recordings and music publishers (and their collection societies) who control the rights to songs.

Many media commentators argue that the service will soon be out of business unless it can get more people to pay for music – with commentators saying that the adverting funded model will not work and Spotify needs to rapidly increase the number of its two million UK users who pay the subscription. Currently it is thought only about 10% pay and indeed Ek, writing on the company's blog to mark the first anniversary this week, said

"Spotify has a long way to go but continued support from the music industry in the face of a recession and rampant piracy has made the difference and I feel that we are set up to succeed with this kind of willingness to innovate and try new things from the music industry... together we can do even better things",

adding

"it's been an interesting year within the music industry, with many insiders questioning whether Spotify's model is a sustainable one. Meanwhile, it's been amazing to see just how our users have taken Spotify to their hearts".

Clearly everything is not all rosy in Ek’s world and he took a shot those knocking his business model (and Spotify’s future success) saying

“the notion of overnight success is very misleading and actually rather harmful to any hope for long term and sustainable growth in this industry. Yet this is unfortunately something the music industry as a whole is particularly good at, expecting business models to be proven within months of inception. The truth is that even the most successful digital business to date, iTunes, missed its revenue targets in its first year by 30%, and label executives were far from convinced that this was the future. We are in this for the long haul. We aren't interested in just trying to hype the company and then 'flipping it'".

That said, one music executive commented “Spotify will be dead within a year if it carries on like this”.

Ek goes further with his criticisms which he said were stopping the music business from properly capitalising on the potential of digital, in particular the labels' and publishers' continued obsession with per-click royalties rather than profit share deals. Against a background of record industry’s core business model -- shrinking by 15% year on year -- he may well have a point. Ek argues that, if record labels and publishers approached digital with a different mindset, then music could become a "$40-50 billion industry and [grow] stronger than it ever has [before]" but Ek argues that this would not happen while labels continue to try to "squeeze as much as possible out of every single transaction".

Fascination about the specifics of Spotify's business model remains, particularly given that Ek's comments on the need for further change in the music sector suggests that he recognises the deals his company is currently tied to may not add up long term. Whilst Ek had been silent on the detail of Spotify’s deals and finances but he did reveal that advertising revenues had now passed "millions of Euros per month", and that Spotify was already 7Digital's biggest download affiliate and this: an announcement of a subscriber base between 100,000 and 600,000 users in six countries, which has provided some basis for speculation and some speculative calculations that, I am pleased to say, have been undertaken by others rather than this blogger!

First off, Pinsent Masons’ wonderful www.out-law.com estimated that Spotify’s subscription revenue was anywhere between £1 million and £6 million per month based on Ek’s rather fluid analysis of premium subscribers and, with each paying £9.99, this gives estimated annual earnings of between £12m and £72m. Then the Guardian's Technology Editor Charles Arthur analysed all of the available information on Spotify costs, with help from Steve Purdham, the founder of Spotify’s rival We7, and the pair started to put some maths together. This turned into a major exercise, not least because Arthur's original calculations missed off any record label royalty payments for using the sound recordings, focusing only on PRS payments for the use of the song and technical streaming costs. Arthur’s blog morphed and it became clear it was almost impossible to work out what sums of money Spotify is currently spending and, possibly, losing, not least because the chances are that Ek has done special deals with the labels and the PRS and that Spotify isn't paying industry standard rates.

Purdham's input provided some interesting insights - "By going for scale, Spotify creates the problem that the cost base for the music is so high. The costs make the “freemium “model, pushing people to subscriptions, hard to handle”.

Arthur’s maths are based on UK figures as the PRS rate (for the use of songs) is public with Purdham saying "Until July 1 (when the new PRS licensing change came in) the perceived wisdom was that the total cost of a stream was publishing plus label cost was 1p in the UK, 1 Euro cent. Purdham also pointed out that Arthur’s “ suspicions were right: the UK's MCPS/PRS publishing organisation collects 0.085 pence per streamed track, or 10.5% of your revenues, whichever is greater (and Purdham says that the UK's publishing costs are probably the cheapest in Europe). There are then hosting costs and the costs paid to record label saying that the hosting cost comes to about 0.03 -0.04 pence per stream and that the labels get about 0.8p per track streamed”. Purdham and Arthur then take’s Spotify’s own publicity material which says "Billions of tracks are streamed every month" and so taking a low estimate if 2 billion tracks per month streamed the maths is relatively simple – the costs will be approximately 0.9p per track x 2 billion - and that means that Spotify apparently owes £18m per month in music licensing costs. Even taking a the highest level of Out-law.com’s estimated income per month (£6 million), this is against three times as much per month owed in licensing charges.

Arthur then makes the point that there is a obviously a significant gap that would need to be plugged by adverting. He summarises thus:

“The final answer therefore on Spotify's costs? Much more - in theory - than my previous estimate. But, in reality very probably much less in reality than the calculations suggest. All the signs are that Spotify is getting an easy ride from the record labels, because the raw numbers would suggest that it's burning through anywhere north of £10m per month - which, even with the generous funding it has had, would simply be unsustainable”.

On the evidence available it does seem that the labels have, to an extent, been supporting the new service in return for a significant shareholding for a number of labels in Spotify. This might show a willingness of the labels to adopt realistic business models in the digital age although it does bring into question the position of the recording artists whose recordings are being used and who rely on royalties themselves - and are not shareholders in the service – and indeed whose sound recordings appear to be in the position of being licensed to a new service part owned by their own labels.

http://www.out-law.com//default.aspx?page=10434
http://www.guardian.co.uk/technology/blog/2009/oct/08/we7-spotify-music-licensing-figures

Stream may run dry for fans of free music The Times October 9th 2009 p32

Is Spotify a Trojan Horse for Music Record Labels? http://www.itproportal.com/portal/news/article/2009/10/9/spotify-trojan-horse-music-record-labels/